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Bank-crisis losses can be avoided with higher capital buffers: IMF

It suggests regulators urge banks to raise new equity rather than pare assets, and says emerging-market banks might need stronger buffers
Friday, March 4, 2016 - 05:50

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Unrest on the doorstep of Greece's central bank in Athens last November. The impact of the changes to banking rules under Basel III is already visible in the evolution of capital ratios for large banks in advanced economies. Those who support appropriate capital requirements point to the costs of the global financial crisis as a cautionary tale; those against it say it raises the cost of bank credit and crimps economic activity.

Tokyo

BANKING crises tend to be quite frequent and costly, not only for bank depositors and creditors, but also for taxpayers. Such crises can be avoided, however, without prohibitively large increases in bank capital, the International Monetary Fund (IMF) has said in a new global study.

It suggested in its study, published on Thursday, that regulators should encourage banks to raise new equity rather than pare assets in order to get within officially-mandated capital-to-asset ratios.

The study comes at a time when banks in Japan, Europe and elsewhere are being urged to use funds generated by central bank quantitative easing (QE) programmes to step up lending and thus revive economic activity.

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The report said: "Had banks had sufficient buffers to absorb losses in the range of 15 to 23 per cent of risk-weighted assets, most (recent banking) crises would have been avoided - at least for advanced economies."

In emerging markets, however, bank losses in times of crisis have been greater in relation to bank capital, the report noted, implying the need for possibly stronger buffers beyond those in advanced economies.

The IMF said that this finding is broadly consistent with recent recommendations on total loss absorption capacity by the Financial Stability Board, and also accords with the recommendations by the Bank for International Settlements (BIS) for systemically important banks.

The suggested size of buffers is well beyond what banks were required to hold up to the time of the 2008 global financial crisis; back then, the so-called Basel rules required a capital-to-risk-assets ratio of only 8 per cent.

The Basel III rules introduced by the BIS have raised minimum bank capital from 8 per cent to up to 15.5 per cent of risk-weighted assets. They have also tightened definitions for risk assets and require banks to link capital to their degree of financial "leveraging".

The deadline for meeting these rules has been extended to March 2019, and banks are at various stages of meeting these Basel III requirements, which apply to "systemically important" institutions and are imposed at individual bank level.

The impact of the Basel III changes is already visible in the evolution of capital ratios for large banks in advanced economies in the US, Europe, and Asia, the IMF noted.

"Few issues have elicited a more contentious debate than the appropriate level of capital requirements," the report said.

"Proponents of stricter regulation point to the risks associated with high bank leverage and the exorbitant costs of the global financial crisis.

"Opponents of higher capital requirements argue that these may significantly increase the cost of bank credit and hinder economic activity."

The IMF report suggested that banking supervisors encourage banks to increase loss absorption by raising equity - either through new issuance or retained earnings, rather than by shrinking assets to avoid reduced-credit availability.

It also warned that tighter requirements on banks may provide stronger incentives for regulatory arbitrage and increase the risk that activities might migrate to unregulated or less regulated financial intermediaries (the so-called shadow banking system)."

Protection against the most extreme banking crises, especially in the case of emerging markets, could require capital and other buffers beyond those recommended for systemically important global institutions, the report said.

But improvements in the quality of bank regulation and "widening the perimeters" of such regulation could also reduce risks of a costly banking crisis as an alternative to providing larger buffers against losses.

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